Weekly Trade Plan

Friday was a ripper, but the move was really not a surprise here. In my trade plans I had outlined a target of the $ES 1802-1803 zone with a risk upside of 1806-08. In good old bull fashion we got to 1805.67 and we profited nicely with long positions. So now what?

First a look at what the market has done in the short term. As you can see from the chart on the right the $ES had build and confirmed an inverse H&S in the November time frame. The most recent pattern is suggesting a potential H&S pattern. In this raging bull market H&S patterns have been more miss than hit so in a vacuum it is a pattern to be viewed with a healthy dose of caution. As I outlined before the recent wedge break still opens the possibility to a move toward the 1820 area. For now I have marked 1809 and 1812 as the next resistance levels. There is a distinct chance that these levels can be tested on Monday as we kick the week off with another strong POMO action by the FOMC. However, I have several reasons to want to trade this market from a sale oriented perspective for at least this week.

Let me walk you through my rationale and strategy. First off recognize that they managed to close the $ES futures green for 9 weeks in a row. Again extremely rare. Now you may want to believe markets will go on higher every week for the rest of the week and trade with that belief and maybe you are right, but from a risk/reward perspective I do not view this as the probably scenario. In fact the pattern we have seen the past few weeks now closely resembles the pattern we have seen at the beginning of the year. If you believe in fractals that chart to the right is quite powerful. It opens the door to two scenarios:

1. If the market follows the fractal to the letter we would see a quick down move next week pointing into the 1760 area and a quick bounce to close roughly flat for the week followed by a move to new highs by the end of the year.

2. A deeper corrective move would likely want to test the 21 weekly MA and the trend line that the market has followed all year both of which currently reside near the 1720 area.

Besides the fractal there are other signs that signal that this corrective action last week is not over with a one day rally. For one the divergences on new highs and new lows is becoming glaring. While divergences have built in the markets all year to little effect this one is getting a bit extreme. At the very least it is pointing to the fact that this rally is, and has been, getting weaker. Combined with ever decreasing volumes it is not a rally of conviction. In this weekend’s general market update I am giving a bit more perspective on the macro view. Bottom line this is a move I want to sell not to buy.

Other signs of caution abound. Many indices continue to be vastly overbought on weekly timescales but this week also showed so called hanging man patterns on daily and weekly charts. For today’s post I’ll use the $QQQ as the leading example here. Strong as heck the cubes have powered on to new highs. But frankly what is this? With weekly RSI at 80.63 we see a black candlestick and a hanging man pattern. That’s a clear bearish signal especially in view of the established track record of the past several years (see chart).

Next factor: 10 year rates. Nobody seemed to care that the 10 year tested the 2.9% level on Friday. Bonds are screaming that taper is coming and higher rates are ultimately a threat to the cheap money boom that has facilitated the earnings mirage that is buybacks. Now the market may signal that it has changed its view on taper on Friday, but I don’t interpret it that way. Any move above 3% on the 10 year is a risk factor for longs here. And given how overbought markets are my sense is they are highly vulnerable to a quick move down.

Last, but not least have a look at the monthly QQQ chart: For a year this market has chugged along at the upper monthly Bollinger bands for most key indices, and each month is tested the month 5 EMA or at least got near it. November it disconnected and for now the $QQQ is completely above its monthly BB band. Buy that if you wish, but no thanks, I smell tulips. This chart, imho, screams a pullback to at least its monthly 5 EMA. The equivalent target for the $SPX is 1750 btw, nicely aligning with the fractal i pointed out above.

My strategy then this week:

On Friday I started scaling into swing short $ES positions. I will continue to scale toward 1812. If we break 1812 I must acknowledge the market is moving higher into 1820-25 most likely. Depending on the action I may cover near 1812 then. However as my target is the 1750-1760 area my R/R is a 5-6 point loss (if I scale in the range average from 1802 to 1812) versus a 50-60 point upside trade.

In addition, as I expand the swing positions on the $ES I will augment trades with option trades. For example I’m prepared to enter intra-day call trades if we swing above the Friday highs. The aim is to keep me flat on the $ES swing short trade as much as possible.

In my mind the short window remains open until the end of this coming week, possibly beginning of next week. As the Fed meeting is the following week I expect volatility to increase into the meeting.